- The Washington Times - Thursday, October 13, 2005

Q:What’s up with the Fed and interest rates? I took out a home equity line of

credit a year and a half ago. We built a big addition to our house and have drawn $150,000 against the line. My payment has jumped from $500 per month to almost $900.

Is there anything we can do to stop the bleeding? I keep hearing that rates are just going to keep rising.

A: Your payment keeps rising because your home equity line of credit (HELOC) is probably tied to the prime rate. A year and a half ago the prime rate was sitting at 4 percent. Today, it’s at 6.75 percent and likely to move up a bit more.

The prime rate is a benchmark for many commercial and consumer loans, including most HELOCs. The Federal Reserve doesn’t have direct control of the prime rate, but it is influenced by Fed policy. So when the Fed decides to raise certain rates it controls, the prime will follow.

The Fed controls the federal funds rate, which is the rate that lenders charge each other for overnight funds.

Fed Chairman Alan Greenspan has announced increases in the federal funds rate 11 times in the last 18 months in an effort to stave off inflation. The widely accepted belief is this: An economy that grows too fast results in low unemployment, but can cause inflation, which can be disastrous. A weak economy will keep inflation contained, but can result in high unemployment.

The Fed policy is to find the perfect economic bowl of porridge — the right balance between economic growth and rising prices. After September 11, the Fed lowered rates several times in an effort to jump-start a shaken economy, which was growing at an anemic 1.5 percent.

It worked. The economy soon picked up steam and is growing at a much healthier pace — currently growing at 3.50 percent.

But Mr. Greenspan fears inflation, and the Fed is not afraid to raise interest rates as a pre-emptive strike, so folks like you who have prime-based loans are feeling the pinch.

You do have alternatives. There is a very thin spread between long-term rates and short-term rates, resulting in a flat yield curve. Traditionally, the spread between short- and long-term rates is much wider, which is why, for example, an adjustable mortgage carries a lower rate than a fixed loan.

You’re in luck. Your prime-based HELOC is costing you 6.75 percent and will likely rise more. A 30-year fixed-rate loan carries a rate of about 6 percent with little or no closing costs.

This scenario doesn’t happen very often. A year and a half ago, when the prime rate was 4 percent, 30-year fixed-rate mortgages were closer to 6.50 percent.

The flat yield curve is drawing people to fixed rates. Speak with a reputable loan officer who can help you rearrange your mortgage debt.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail (henrysavagepmcmortgage.com).

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